Thursday, October 30, 2008

The World's Central Bank

The dollar is, de facto, the world's reserve currency, which is why we've seen it strength against almost everything else as investors delever and switch to cash.

However, the US Central Bank traditionally only lends to american banks. Thankfully, it is now lending to banks of all nations so they too can borrow the dollars they need. The US Government is now lending directly to commercial banks, investment banks, insurance companies, auto companies, any business large enough to have commercial paper, Japan, UK, Switzerland, the EU, Brazil, Singapore, Korea, and Mexico. This is all well and good, because it formalizes the current state of the financial world: the US dollar is the world's reserve currency, and the Fed is the world's central bank. Some of the nations the US is lending to have a largely dollarized economy anyway: Brazil, and Mexico. The rest should ditch their currency and embrace the greenback too.

The IMF, which is de facto a part of the US Government, has been lending dollars to pretty much everyone else. The US should open up a swap line with the IMF, or even better, just fold that thing officially into the Fed.

It seems that only China and Russia are left out of the party. China's exclusion is particularly interesting because they've been sending us real goods, like TVs, cars, and washing machines, and all they have in return is this pile of US Treasuries! It's like a joke t-shirt.

As Brad Setser has been dutifully tracking for years now, almost all the long term demand for US Treasuries has been coming from the Government of China, who have been buying these things as a matter of policy. In the short term, this policy has stuck China between a rock and a hard place: if they stop buying Treasuries their export industries will suffer, but if they keep buying Treasuries they will be left with ever larger piles of Treasuries that the US can devalue (or not) whenever it wants.

Finally, with housing prices still 30% above historical trends, we have academics like Marty Feldstein saying the Government should prop them up "to prevent overshooting on the bottom". Nice to see that everyone is staying focused on the right things.

My preferred solution is for the Government to just mail everyone a check for $1M. Problem solved. For those who cry that "tax payers writing checks to themselves" cannot work are mistaken -- government money does not come from taxpayers.